The Story of A & B (and Their Kids C & D)
Jeff Haggerty & Delwin Graham - Nov 28, 2019
Being that November is financial-planning month, we asked Jeff to provide us with an advanced case study to illustrate the typical clients he sees and the solutions he offers.
Jeff Haggerty, CFP, CLU, FMA, is our Wealth and Estate Planning Specialist, and he has been doing great work for us. Being that November is financial-planning month, we asked Jeff to provide us with an advanced case study to illustrate the typical clients he sees and the solutions he offers. Jeff is a no-nonsense kind of guy. Below is the case of a couple in the their mid-40s (call them A & B) and their two children in their early 20s (call them C & D).
A is a successful small-business owner (civil engineering firm with 20 employees) starting to accumulate wealth in his company. He’s looking for retirement income planning with some tax and estate advice. A advised that his one son, C, is studying civil engineering and may take over the company when A plans to retire. He is partners with another individual who is in his 50s. This partner eventually wants to be bought out.
- By the time he is 60, successfully transfer the business to his son. He wants to know what it would take to be able to retire with $10,000 per month, inflation adjusted.
- Help pay for his kids’ education.
- Ensure that the business would continue even if he died prematurely and ensure that his family is protected in the event of death or disability.
- Ensure that his estate plan is in place.
- Look at general tax-planning strategies.
Through our financial-planning process, we identified several gaps and solutions:
- One issue pertained to the new tax rules around passive income. He was accumulating excess funds in his Holding Company (HoldCo) and was at risk of eliminating his small-business deduction for his corporate earnings less than $500,000. We had to identify strategies for this.
- He was accumulating investment assets in his name, and the income from the portfolio was all taxable to him. He is taxed at a marginal rate of 48%. He was not implementing any income-splitting strategies.
- We had to identify ways to help pay for the rising costs of tuition for the kids. He wanted to use some of the funds in his business for this purpose.
- The couple’s wills were very general and did not elaborate on what would happen to the business if A were to pass away prematurely.
- There was no succession plan for the son, C, to take over.
Strategies identified and implemented:
- To get money out of the Operating Company (OpCo), we recommended setting up an Individual Pension Plan (IPP). This allowed a Past Service Funding deduction of $200,000 and an advantage over conventional RRSPs by allowing much larger deductions. It also allowed his management fees to be deductible and allowed funding when there was poor market performance. We also considered a Retirement Compensation Arrangement (RCA) to get more funds extracted from the company.
- We also looked at a Corporate Insured Retirement Strategy using permanent insurance with cash values to shelter some of the capital inside the company. This prevented annual taxation of the investment capital and provided cash for the estate for his final tax liability which was estimated to be over $1 million. He could also access the cash value through annual loans (tax-free) at a low-interest cost if he needed more funds for his retirement.
- We set up a Spousal Loan, where A lends B cash at the prescribed rate of interest, reducing the taxation of the investment income from 48% to 15%.
- We had his corporation lend money to the kids for their education. This allowed the loan to be reported under the kids’ names, and the taxes payable on the loan was reduced as they utilized their tuition tax credits. This ended up being more tax efficient than paying out a higher salary or dividend to A.
- We recommended an estate freeze utilizing a family trust. This allowed some of the future growth of the company to accrue to the children and the spouse. Upon a future sale, if applicable, it would allow a multiplication of the lifetime capital gains exemption, allowing for more tax savings. It also capped the tax liability on death for A and would start to transition the growth to C once he is ready to take over. Once A retires, his preferred “frozen” shares could be redeemed over time to provide for his retirement income.
- To protect each other’s interests, including the future shares going to the son, we looked at drafting a buy-sell agreement with the partner and funded it with life insurance.
- We discussed detailed estate planning and looked at ways to be fair to the other child in lieu of C inheriting the business. Wills were redrafted. Enduring Powers of Attorney and Personal Directives were drafted.
- We presented a retirement-savings strategy on how much to contribute to the IPP, both TFSAs, the Corporate Insured Retirement Plan, the non-registered portfolio, etc. We reviewed what assets to invest in and where to provide the most tax savings.
- We then illustrated a road map of how it would all look upon his retirement at age 60: where to draw from, how much to expect, when to use pension income splitting, etc.
The case that Jeff provided is entirely fictional, so any similarities to actual people are unintended and entirely coincidental. As always, before implementing any specific tax or legal advice, you should consult accountants and lawyers specializing in those areas; however, Jeff is a good place to start. He is a Certified Financial Planning Professional (CFP®) and Chartered Life Underwriter (CLU®) with almost 20 years of experience in wealth and estate planning at a major insurance company, the investment-dealing arm of a major bank, and now at Canaccord Genuity. He spent most of this time thinking “outside the box” and helping clients in more complex situations—such as professionals (doctors, lawyers, etc.), business owners, and farmers—find tax-efficient solutions to retirement, succession planning, and other life goals.
Please contact us for a complimentary review of your situation.